Mutual funds offer a convenient way to buy a portion of a diversified portfolio in a single transaction. Many mutual fund companies offer a variety of individual funds and allow you to easily transfer shares between funds. However, excessive trading creates a burden on mutual funds, and they may penalize you for it. If you sell mutual fund shares and repurchase them within 30 days, you’ve created a “wash sale” that can affect your taxes.
Open-end mutual funds stand ready to create new shares for the cash they receive from investors. They also must cancel the shares that an investor redeems. Many mutual funds consider buying and selling shares in the same fund within 30 days to be excessive trading. Funds call these transactions “round trips” and urge investors to avoid them. Round trips can hurt long-term returns by creating additional brokerage commissions and administrative costs. They can also disrupt the fund’s investment strategy by forcing untimely portfolio purchases and sales.
Mutual funds can discourage round-trip trading with fees and blocks. A mutual fund might impose a redemption fee on round-trip trades. The U.S. Securities and Exchange Commission allows funds to collect a redemption fee of up to 2 percent of the share value. Some funds block additional purchases for repeated instances of round-trip trading. A mutual fund company might even impose a company-level block, preventing you from buying any fund they sell for a period of weeks or months. If you are prone to make many round-trip trades, you might consider using exchange-traded funds instead of mutual funds -- ETFs have no round-trip restrictions.
The Internal Revenue Service considers the sale of securities, including mutual fund shares, that you subsequently repurchase within 30 days to be wash sales. You cannot take a tax deduction on a capital loss arising from a wash sale. Instead, you must add the disallowed loss to the cost basis of the replacement shares. In effect, the wash sale rule delays your recognition of a loss until you sell replacement shares that you’ve held for more than 30 days. Your mutual funds will send you IRS Form 1099-B after the end of the year reporting your capital gains and losses, including wash-sale proceeds.
The easiest strategy is to avoid round trips. If you must sell shares within 30 days because of mandatory retirement distributions or systematic withdrawals, notify the fund of your reason, and it might not penalize you. Money market funds are normally exempt from round-trip penalties. You can avoid wash sales by repurchasing shares that are similar, but not identical to the sold shares. For example, if you sell a small-cap mutual fund from Fund Company A, buy replacement shares from a different small-cap fund offered by Fund A or buy shares from Fund Company B instead. You cannot avoid wash sales by selling shares in your regular brokerage account, then repurchasing them in your Individual Retirement Account within 30 days.
- Fidelity Investments: Fidelity’s Excessive Trading Policy
- Alerus Financial: What Are Mutual Fund Redemption Fees and When Are They Charged?
- U.S. Securities and Exchange Commission: Mutual Fund Fees and Expenses: Redemption Fee
- Internal Revenue Service Publication 550: Investment Income and Expenses
- TradeLog: IRA Wash Sales Can Have Severe Consequences
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